Correct the incentives - clean-up the mines

Mining is a messy business. To construct a mine large amounts material including topsoil and waste rock must be removed from the site. Extracting, milling and refining the ore produces an end product, which may for example become something shiny on your finger or a frame for your new Tesla. But the operation produces side-products including more waste rocks and tailings. What waits at the end of mine’s life? A big hole with steep cliffs, waste rock piles and vast tailings bonds with pollutants. These pose safety hazards and present possible adverse impacts on human health and to the environment. For example, waste rock piles may cause acid mine drainage and pollute streams.

So what? Why is this problem? Waste rock piles can be covered or they can be used to fill in the holes. And tailings bonds are safely constructed anyway. In principle, yes, but in practice reclaiming the mine lands by the mining firm has not been that simple or successful. It simply might not even occur - Just pay the small bond, and leave the more costly reclamation to the tax payers, as has happened in the U.K. Often, like in Canada, the monies deposited by the mining firms are not enough to cover the estimated reclamation costs. And, it’s quite impossible not to mention here that Team Trump’s recent rollback on reclamation policy is not really happy news either.

It definitely looks like its possible to readjust the instruments to give better results. The most important thing is to have a good estimate on the future reclamation costs at the beginning of the mine’s life. Of course, this estimate should be as close as possible to the real costs, which are revealed in the future when the mine is shut-down and the reclamation is actually performed. Let’s take an example from Mitchell and Casman (2011), whose interest is on shale gas production. Based on existing mining policies, they propose the following simple formula for the present value of reclamation costs $P$ to be deposited in a reclamation trust (or to be paid as a bond):

$$P=\frac{C}{(1+r)^T}(1+V),$$

where $C$ is the estimated reclamation cost, $r$ is the interest rate, $V$ is the volatility premium and $T$ is the life-time of the mine. Without commenting the volatility premium, this formula seems to produce the correct amount of funds to perform the reclamation assuming that the data is correct. However, there are at least two problems with this formula and the line of thinking.

First, the formula does not pay any account to the benefits of the reclamation efforts. Presumably the only reason to spend resources on reclamation is that it produces benefits to the people. Hence the benefits should be taken into account. A possible counter-argument is that the above cost $C$ has already been compared to the benefits, and it has been found that benefits are greater than the cost; hence the decision to collect $P$ amount of funds. But by varying the reclamation effort, one varies the amount of benefits and costs. This means that a value that maximizes the net benefits should be found, and when found, one can use the above formula to calculate a different - possibly a more meaningful - present value.

Second, and perhaps more importantly, Mitchell and Casman say that the reclamation cost $C$ is estimated in practice by the mining firm. This is a serious problem:

1. If the present value cost $P$ is not based on net benefit maximization, but simply on the mining firm’s estimate, the cost will be understated. There’s not going to be sufficient funds for the eventual reclamation.

2. If the present value cost is based on net benefit maximization, it is in the mining firm’s interest to overstate the cost, since it means lower required reclamation effort and cost.

Either way, and to say it plainly, shit hits the streams. However, even though the mining firm has better information about the future reclamation costs, the regulator is not totally toothless; by following certain principles from economic literature, the regulator can design a reclamation contract that the firm finds profitable to accept and which yields the maximal (expected) benefit for the society.

Written on March 24th, 2018 by Pauli Lappi